The best time to figure out if you’re making too much money, which means you’re doing something dangerous, Cramer said Wednesday, is during a rally. These moves offer a chance to see if your portfolio is carrying too much risk.
Yes, believe it or not, generating returns that dramatically outperform the averages can be a problem. It’s a red flag, a warning sign, that you could be exposed to some serious downside once the rally is over.
Maybe you were using margin, borrowing money from your broker to boost your profits. But just as that will help you “crush the averages” in rally, Cramer said, it will also “get you crushed by your losses” in a sell-off.
A big jump in your portfolio could also mean you’re not diversified, which is never good. If a rally was led by the oil stocks and your holdings are heavy on Exxon Mobil , Chevron , BP and others in the group, then you’ll be a big winner for the day. “But those gains probably won’t last,” Cramer said.
“If you’re not diversified, if you’re keeping all of your stock eggs in one basket,” Cramer said, “you’re going to get wiped out.”
Just ask anyone who was heavy on tech during the dot-com bubble, ignoring what they thought were other “underperforming” sectors. Well, they may have been underperforming in relation to sky-high tech stocks, but investors who also owned, say, banks, food-and-drug names and dividend-paying companies certainly weathered the ensuing collapse better than those who were all in on the one hot group.
Cramer’s bottom line is that taking unnecessary risk in your portfolio “makes absolutely no sense at all,” he said. “And watching your stocks move in a great rally is a terrific way to tell if you have that unnecessary risk.”
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